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The Tax Regime for Individual Expatriates: Whom to Impress?

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The Tax Regime for Individual Expatriates: Whom to Impress? THE TAX REGIME FOR INDIVIDUAL EXPATRIATES: WHOM TO IMPRESS? Andrew Walker* TABLE OF CONTENTS I. Introduction.556 II. Why Expatriate? The U.S. International Tax Regime for Individuals.558 A. The Income Tax.558 B. Wealth Transfer Taxes.562 III. The Prior Tax Law Regime for U.S. Expatriates.564 A. Income Tax?Section 877 Prior to Its Amendment.564 B. Estate Tax?Prior Law Section 2107 . 569 C. Gift and Generation-Skipping Transfer Tax.570 IV. An Overview of Expatriation Provisions in the 2004 Act and Competing Expatriation Proposals.571 A. The 2004 Act.571 B. The Exit Tax Proposal.572 C. Essential Features of Prior Law and the Proposed Alternatives.575 V. Legal Limits on the Imposition of a Special Tax on Expatriates.576 A. Constitutional Limits.576 B. Limitations Imposed by International Human Rights Law. 579 C. Limitations Imposed by Treaty Obligations.580 VI. Tax Policy Parameters.582 A. Tax Neutrality.583 B. Equity and Fairness Considerations. 584 C. International Equity and International Comity.587 D. Administrability and Enforcement.589 E. Estate and Gift Tax Policy Concerns.591 F. Conclusions.593 VII. A More Rational Regime.594 Partner, Milbank, Tweed, Hadley & McCloy, LLP, New York, New York; University of Cape Town, South Africa, B.A., 1990; M.A., 1991; Harvard Law School, J.D., 1994. The author is grateful for the research and assistance of his colleagues Drew Batkin, Alan Schwartz, and Benjamin Yu. Tax Lawyer, Vol. 58, No. 2 555 556 SECTION OF TAXATION I. INTRODUCTION The American Jobs Creation Act of 2004 (the "2004 Act")1 includes provi sions to amend the tax regime for individual expatriates. This salvo is the latest in a politically charged exchange about the taxation of expatriates that ignited in the mid-1990s.2 Proposals to replace the current expatriate tax regime with an "exit tax" and treat expatriation as a realization event have been reintroduced a number of times in the Senate and were included in the 2004 Senate Bill that was rejected in Conference.3 While the term "expatriation" is often used interchangeably to mean both the act of relinquishing legal status as a U.S. national and the act of abandoning United States domicile, it is important to distinguish between the two concepts. For most countries, which tax based on residence rather than nationality, it is not a change in legal nationality status, but rather the act of emigrating that alters an individual's tax status as a person generally subject to the country's taxing jurisdiction. The U.S. international tax regime for individuals turns on national ity status rather than domicile, as discussed below. Under the U.S. system, it is the loss of legal U.S. nationality that causes an alteration of general U.S. taxing jurisdiction. Of course, emigration is a necessary condition of expatriation, but it is not a sufficient condition, and, frequently, the two acts do not occur contem poraneously. Legislative attention was drawn to expatriation by the wide publicity accorded a few egregious tax-motivated expatriations.4 The expatriates involved were citizens and life-long U.S. residents who had enjoyed the privileges of U.S. American Jobs Creation Act of 2004, H.R. 4520, 108th Congress, 2d Sess., ?804 (2004). Sub stantially identical provisions were included in the Treasury Dept., General Explanation of the Administration's Fiscal Year 2005 Revenue Rioposals (February 2005), reprinted in 2004 Tax Notes Today 22-20 (Feb. 3, 2004) [hereinafter Administration's Proposal] and have been included in a number of House bills, for example, the Chairman's mark of the American Jobs Creation Act of 2003, H.R. 2896,108th Cong. ? 2005 (2003). ^or a general discussion of the political battle over the taxation of expatriates during the 1990s, see Nancy Loube, Expatriate Games: Politics Obscures Technical Issues, 67 Tax Notes (TA) 158 (Apr. 10, 1995); Martin A. Sullivan, Democrats Revisit Expatriate Tax: With Neutrality and Justice for All?, 85 Tax Notes (TA) 407 (Oct. 25,1999). 3Jumpstart Our Business Strength Act, S. 1637, 108th Cong. (2004) [hereinafter Senate JOBS Act]. Provisions to this effect have been a perennial revenue raiser, including, for example, the recent Safe, Accountable, Flexible, and Efficient Transportation Equity Act of 2004, S. 1072, 108th Cong. ? 5652 (2004). See also Staff of Joint Comm. Taxation, 108th Cong., Description of the Highway Reauthorization and Excise Tax Simplification Act of 2004 (Comm. Print 2004). The exit tax was first proposed by the Clinton Administration in its Fiscal Year 1995 Budget Proposal, described in U.S. Dept. of Treasury, General Explanation of Revenue Proposals in Clinton Administration's FY 1996 Budget Request (February 1995). A revised exit tax regime was then proposed by late Senator Moynihan, S. 700, 104th Cong. (1995) [hereinafter Moynihan Exit Tax Proposal]. ASee, e.g., Laurie P. Cohen, Kenneth Dart Forsakes U.S. for Belize, Wall St. J., Mar. 28, 1994, at Cl; Robert Lenzner & Philippe Mao, The New Refugees: Americans Who Give Up Citizenship to Save on Taxes, Forbes Magazine, Nov. 21, 1994, at 131; Karen de Witt, Some of the Rich Find a Passport Lost is a Fortune Gained, N.Y. Times, Apr. 12,1995, at Al. Tax Lawyer, Vol. 58, No. 2 THE TAX REGIME FOR INDIVIDUAL EXPATRIATES 557 nationality and residence, including the opportunity to accumulate vast wealth. They then expatriated to sunny tax-havens, presumably to avoid U.S. taxes, while maintaining significant continuing contacts with the United States. Faced with facts like these, a legislator's reaction to fulminate then legislate is under standable. Nevertheless, while this may be the situation at which the current expatriate tax regime is primarily aimed, it does not describe the situation of many, perhaps most, potential expatriates. While few have much sympathy for the tax motivated expatriates described above, the current expatriate tax regime captures many other individuals whose situation is more sympathetic. Increasing international mobility has led, particu larly in the case of wealthy families, to significant diversity of citizenship and nationality among family members. It is common for a wealthy family to in clude members who, by reason of birth in the United States, marriage, or other wise, are U.S. citizens or green-card holders and stand to inherit a significant portion of the family's wealth. In its origins, the family's wealth may have had little or no relation to the United States. The actual contacts of U.S. citizen family members with the United States may range widely, from the individual who has chosen to make the United States his or her home, to the individual who takes advantage of his or her status to study or to reside temporarily in the United States, to the individual who maintains little or no actual contact with the United States but retains U.S. citizenship or a green card primarily to ensure access to a stable safe haven in the event of political instability at home. Yet all are fully taxed by the United States on their worldwide income on the basis of their nationality status. The appropriate tax regime for individuals who expatri ate in these circumstances may be far less intuitive. The United States was among the first countries to recognize expatriation as an important right. At common law, sovereign allegiance was immutable. The common law doctrine of "perpetual allegiance" denied a subject the right to sever his allegiance to the place of his birth.5 The rule was widely recognized, initially even in the United States. However, American attitudes to the doctrine soured when the British vigorously asserted the doctrine to justify impressing captured British-born, U.S.-naturalized sailors into service in the British navy. American outrage led ultimately to the War of 1812.6 While U.S. citizens today enjoy a statutory right to expatriate,7 these former citizens navigate treacherous international tax waters. Which expatriates are the United States able to capture in the extra-territorial exercise of its taxing power? 5See, e.g., Calvin's Case, 77 Eng. Rep. 377, 382 (K.B. 1608) ("ligeance or obedience of the subject to the Sovereign is due by the law of nature."). See generally Peter J. Spiro, Dual Nationality and the Meaning of Citizenship, 46 Emory L.J. 1411 (1997). 6See Charles Gordon, The Citizen and the State: Power of Congress to Expatriate American Citizens, 53 Geo. L.J. 315, 319 (1965). See also 3 John Bassett Moore, A Digest of International Law ? 439 (1906) (discussing the U.S. furor in 1866-67 over the refusal of Great Britain to recog nize the right of native British subjects to divest themselves of allegiance by naturalization in the United States, in the context of their participation in the Fenian movement). 7See Immigration and Nationality Act, 8 U.S.C. ? 1481 (2004). Tax Lawyer, Vol. 58, No. 2 558 SECTION OF TAXATION Which captured expatriates should it impress? Should the expatriate tax regime satisfy domestic tax policy norms, conflicting international tax norms, or serve merely to impress upon the electorate that their elected representatives share their distaste for wealthy taxpayers who seek to escape their fair tax burden? Part I of this Article compares the U.S. tax regime for citizens and permanent legal residents to that for nonresident aliens and explains the income tax and wealth transfer tax advantages of expatriation. Part II summarizes the current law regime applicable to expatriates, primarily under section 877 of the Code prior to the changes made by the 2004 Act. Part III summarizes the changes adopted in the 2004 Act and the competing Senate proposal to adopt an exit tax imposed on a mark-to-market basis.
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